How to be prepared for a potential recession (2)

Further to my blog last week, today I’d like to provide some thoughts about what I’m doing or will be thinking to do in anticipating a potential recession in the next 1-2 years. But let me be very clear from the start that this is not something for quick profits. Actually except those dividend stocks or gold stocks that I do considering potentially very profitable in the long run, the other measures are more for protection purpose. Just like insurance, you pay a little money to protect from a disaster but you hope the disaster will never happen and you don’t expect to see any profit from the premium you pay. This is kind of mindset you should have here as well. Also, unlike some people who may think that what is not happening now is not something that will happen and needs to be worried about, I treat it as a devastating trend that we need to be well prepared for and therefore you need to have a long-term strategy in place. OK, let’s go into the details.   

• Regardless whether a recession will hit or not, it is always a must to build up a long-term portfolio with quality stocks, especially those with track record of paying increasing dividends for decades. I’m fanatic about dividend reinvestment for long term. Such stocks will not only fares much better in a recession, the declining prices of such stocks will actually bring you more wealth than increasing prices over time. You can sleep well with them as you know they are making money for you regardless what happens. From time to time I discussed such quality stocks here and will continue to bring some ideas when the time is right. But for now, you may consider WMT and TJX. They have been under pressure lately but they tend to do well if indeed we are moving towards a recession.

• I hold a lot of precious metal positions as I believe gold/silver has started its next bull run. They will also be one of my major hedges against the market downside risk. As I talked about a few times in the past few months, a sizable correction is ongoing in this sector. I think gold may challenge its next strong support around $1200 in the weeks ahead. But I’m super bullish about gold and silver for years from the long-term perspective and will take this correction as a great opportunity to buy more.  

• Now more speculative measures as insurance against a recession. There are a few ways to do it. Again, keep in mind, the following ideas are generally going against the market. There is no hurry to open such positions but do take your time. We may see a wonder rally towards the year end, especially if H Clinton wins the election. This will be a great time to gradually buy the hedges when they are cheap.
• I must say the market seems very comfortable and complacent at the moment, considering the degree of risks involved.  With the volatility index near its all time low, buying some inverse funds to hedge for your overall portfolio should be considered. Here you can find more detailed information about such ETFs. One ETF in particular I’m interested in is SEF. This is an inverse fund against the financial sector. If we are indeed going into a recession, the financial sector is likely one of the leading forces to bring the market down. Buying SEF gradually at its dip will be my strategy. 
• More aggressively, having some short positions should also be considered if one is comfortable with doing that. Think about it, when the overall market is in big trouble, what will fall the most? Those already being struggling financially and better are on their way to bankruptcy!! A couple of such companies you can consider: SHLD (anyone still shopping in Sears?), IHRT (the largest traditional radio station in US; anyone still listening to such radio?),  DB (the biggest trouble boy in the EU banking system that may trigger a worldwide Tsunami), and VRX (still tremendously struggling legally and financially). You may directly short them but considering it is not a short term play, a better way to short them is to buy long-term deeply out of money put options. The idea is to spend very little money but to get 10 times more money back if they indeed crash over the next year or two.  If you don’t know how to play with option, better spend some time to study and master the technique as it is a fantastic way to help you minimize your risk with much less capital needed.
• Last but not least, a more complicated option strategy that can work very well to protect your holding positions. Let’s say you have a few long term stocks that are doing very well and you want to continue to keep them. Naturally you don’t want to see them go down even on paper, right? Here comes handy with the so-called Collar strategy, that is exactly for this purpose. Briefly, against your withholding position, you sell the equivalent number of contracts of long term calls at or slightly above the current price and at the same time, buy the same dated puts at or slightly below the current price. This way, you use the premium got from selling the calls to fund the premium you pay for buying the puts. Quite often you end up with even and pay nothing to establish an insurance that will totally protect you from a disastrous crash of the stock.  Sounds confusing? Well, believe me, your time and efforts will be very well worth to spend to fully understand it.

I hope this little blog can help you at least to open your mind to start thinking about what and how to be prepared for a recession that may hit us in the months ahead. The trend is not great, considering we are seeing continuously declining GDP quarter after quarter and now the contraction of manufacturing activities. As I said before, we haven’t felt the recession yet simply because everything has been largely manipulated by the Fed with unchecked supply of money. But wait to see what will happen when the Fed finally starts to seriously move interest rates up.